2013 Inflation Outlook

I would ordinarily step back from any opportunity to wager. Thus, I never cease to wonder at the celerity with which my football-loving friends put their nairas where their mouths are. I am not sure whether this phobia is because chance occurrences make nonsense of rationale processes. Or if it is the product of a conceit that hates to lose. Conversely, I confess that in herds (or do they go about in schools?) numbers discombobulate me. But after trawling through the communique of the meeting last week of the Central Bank of Nigeria’s (CBN) rate-setting committee (the Monetary Policy Committee ‒ MPC), I do believe that there is now a 75% probability of the January 2013 meeting of the MPC agreeing a 25 basis points cut in the monetary policy rate (MPR), that is bringing it down to 11.75%. “Why”, you may ask?

For starters, the MPC did not surprise by its decision at its November meeting to leave its main levers unchanged. As expected too, consumer prices strengthened, with the headline figure rising by 40 basis points to close October at 11.7%. How much of this increase in the inflation rate was the result of the floods that swept through the nation’s bread basket a month or two ago? Available evidence is both sketchy and anecdotal, but the 90 basis points rise in the food index (closed October (at 11.1% year-on-year) is a useful pointer. No less indicative is the fact that computed month-on-month, the food index for October rose by 100 basis points. Correlation is, of course not sufficient evidence of causation, however. On the other hand, the degree of responsiveness of domestic prices to similar price shocks this year, counsel that this numbers be taken with the proverbial pinch of salt.

Still, even if the flooding and its attendant abridgement of the national food supply has driven food prices up (which in turn has the consumer price index out of kilter) we may yet doubt whether we have witnessed full pass through of the flood effects to domestic prices. My sense of this is in the negative. Most of the pressure on food prices captured by the NBS’ October numbers showed up in the urban measure. It is odd, given that much farming in the country is a rural area activity that the rural food index was flat. Is there a displaced persons effect? Supplies to the numerous displaced persons camps set up since after the floods would have come off urban purchases. Ought we then to dread the gradual return of those displaced by the floods? And will the effect of their return on the rural food index qualify as a second-round shock?

Conversely, is “displaced persons effect” a bigger source of disquiet than the fall in core inflation numbers in October? This matters, because core numbers are more important for anchoring inflation expectations than headline numbers (which include the more volatile bits of the index). The CBN has long explained sticky (and high) core inflation as a consequence of structural constraints in the economy. Indeed the most recent meeting of the MPC argued that “the major drivers of core inflation remained outside the scope of monetary policy alone which was helpless in addressing the structural components of inflation”. At a point, the argument was simply that this measure of domestic prices had reached as low as it could be nudged by monetary policy alone. There was increasingly a compelling requirement for further (structural) reforms to the economy to push core inflation down. Remarkably, the NBS explained the 70 basis points drop (to 12.4% in October y-o-y) in the core inflation number as due to the “uncompromising monetary policy on the part of the Central Bank of Nigeria (CBN)”. Given that the deceleration in core inflation has been on for the past four months, it is either that the CBN does not have as much a sense of the strength of the tools in its kitty, or that surreptitious reforms to the economy have been underway in the last one year (include a lag of about six months) that are finally addressing the structural impairments to the economy’s proper functioning. Whatever the explanation for these conflicting signals (or noises?), the MPC believes core inflation to be still too high.

This is where we loop back on the wager with which I opened this piece. The MPC may argue ceaselessly (in the words of the communique from its most recent meeting) that the “conflicting price signals coming from the latest inflation numbers from the NBS” create “uncertainty as to the appropriate policy stance at this time”. But the clincher for determining the policy rate over the next six months will be the economy’s slowing growth rate: 6.48% in the 9 months ended September 2012; up on the 6.39% for the 6 months to end-June; but significantly down on the 7.37% recorded over the same 9 months period last year.

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